Financial Risk Manager Part 1
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A risk analyst working for a pension fund is tasked with calculating the 1-day Expected Shortfall (ES) for a portfolio using the historical simulation method. To do this, the analyst generates 250 different scenarios for the portfolio. Given the context of historical simulation, which of the following assumptions or methods best describes the most effective way for the analyst to estimate asset values for each scenario?
A risk analyst working for a pension fund is tasked with calculating the 1-day Expected Shortfall (ES) for a portfolio using the historical simulation method. To do this, the analyst generates 250 different scenarios for the portfolio. Given the context of historical simulation, which of the following assumptions or methods best describes the most effective way for the analyst to estimate asset values for each scenario?
Explanation:
A is correct. Historical simulation involves identifying market variables (usually termed risk factors) on which the value of the portfolio under consideration depends. Daily data is collected on the behavior of the risk factors over a period in the past. Scenarios are then created by assuming that the change in each risk factor over the next day corresponds to a change observed during one of the days used in the historical simulation.